SEC Commissioner Crenshaw Pushes for Greater Regulation Over Syndicated Loans
Commentary by Steven Lofchie
SEC Commissioner Caroline A. Crenshaw described potential risks to investors and the economy associated with the Broadly Syndicated Loan ("BSL") market.
In a speech titled "In Securities: What Happens When Investors in an Important Market are not Protected?" before the Center for American Progress, Commissioner Crenshaw raised concern about the lack of investor protection, particularly for retail investors, due to the absence of securities laws protections in the BSL market. She argued that institutional investors need these protections as well, referring to the financial crisis of 2007-2008. She highlighted the systemic risk accumulating in the BSL market, which could potentially affect the broader financial system. The private nature of these assets, she noted, prevents regulators from fully assessing whether particular institutions have too much exposure or whether other risks are brewing.
Commissioner Crenshaw reviewed the development of BSLs and raised concern about the legal status of BSLs, which are treated as securities under the Investment Company Act, but not under other regulations. This lack of clarity, she suggested, could lead to market confusion.
To address these problems, Commissioner Crenshaw called for a re-evaluation of the regulatory framework to ensure it remains fit for its purpose. She said that clear guidance is needed on which factors are sufficient for a BSL to rebut the presumption that it is a security. She advocated for enhanced investor protection, suggesting that investors in BSLs should benefit from the protections of the antifraud rules of the federal securities laws, such as Rule 10b-5 ("Employment of manipulative and deceptive devices"). Lastly, she emphasized the need for vigilance from regulators to anticipate and mitigate future risks.
Commentary
One may think of financially regulated products and entities as being in competition with unregulated products and entities. The benefit of the regulated products and entities is that they should be safer; the benefit of the unregulated products and entities is that they should produce higher returns by virtue of not having to bear regulatory costs and not being subject to the same level of regulatory restrictions. In this competition, regulated products and entities are steadily losing. This may be due to the fact that unsophisticated investors are not able to quantify the benefits of regulation and so they elect to take the seemingly higher short-term returns. Sophisticated investors, including of the type referenced in Commissioner Crenshaw's speech, may elect to invest with - and in - unregulated entities and products because they perceive the costs of regulation as not providing a benefit that justifies the lower returns.
The response of regulatory enthusiasts to losing this competition is to adopt more regulations (two more SEC rules adopted on October 13) and to attempt to further limit the ability of market participants to transact in the unregulated markets. An alternative approach would be to consider whether some reduction of the burdens imposed on regulated entities and products could make them more attractive to market participants.
Regulation should be cost-sensitive and cost-effective. As much as investors have suffered losses in unregulated markets (such as in dealing with FTX), those losses actually pale as compared to the taxpayer losses from bank failures. For example, the FDIC estimated that losses from the failures of Silicon Valley Bank and Signature Bank would be about $22.5 billion and that the costs of First Republic Bank would be about $13 billion. Of course, these losses fall relatively indiscriminately on other banks and their depositors, not on investors, so the pain is more dispersed and arguably hidden. But as far as the economy generally is concerned, these are real losses. One might doubt that there are many unregulated funds that are so poorly risk managed and so oblivious to mismatches in maturity of funding as these regulated banks. It is also not so obvious that the regulated products and entities are a good buy, either for the individual investor, or for the economy taken as a whole. Given the events of the past year, one might reasonably worry more about risks that are accumulating in regulated bank entities, and the fact that those losses will be eventually paid by retail depositors through higher fees, than about the BSL market.